Week in Review

Socialists who attack capitalism say they are the champion of the poor. And yet the poorest of the poor are in socialist countries. Where some live without indoor plumbing or electric power. While the poor in capitalist countries can suffer from obesity. And most if not all have indoor plumbing and electric power. As well as refrigerators, microwaves and televisions.

Venezuela is an anti-capitalist, socialist country. So you would think it’s a poor person’s paradise there. But because of runaway inflation only the rich do well in this socialist paradise. While the poor can barely afford to live (see Venezuela jails 100 ‘bourgeois’ businessmen in crackdown by Andrew Cawthorne and Deisy Buitrago, Reuters, posted 11/14/2013 on Yahoo! News).

Venezuela’s socialist government has arrested more than 100 “bourgeois” businessmen in a crackdown on alleged price-gouging at hundreds of shops and companies since the weekend, President Nicolas Maduro said on Thursday.

“They are barbaric, these capitalist parasites!” Maduro thundered in the latest of his lengthy daily speeches. “We have more than 100 of the bourgeoisie behind bars at the moment.”

The successor to the late Hugo Chavez also said his government was preparing a law to limit Venezuelan businesses’ profits to between 15 percent and 30 percent.

So what’s to blame for these high prices? Capitalism? Or socialism? Well, if you blame a devalued currency and a scarcity of basic goods, you have to blame socialism.

Venezuela’s official inflation, 54 percent annually, is the highest in the Americas…

Given Venezuelans’ anxiety over inflation, and scarcities of basic goods from toilet paper to milk, Maduro was risking a backlash at the December 8 nationwide municipal elections…

Critics say the moves do not tackle the roots of Venezuela’s economic malaise, like an overvalued bolivar that forces many importers to buy black-market dollars and then pass those costs on to consumers.

The government has ordered local telecom companies to block various websites showing the bolivar at 10 times the official rate of 6.3 to the greenback on the illegal market.

The socialist economy of Venezuela can’t provide the basic necessities. So they have to import a lot of goods. But before you buy a country’s exports you have to exchange your currency first. And when you’ve devalued your currency by printing money to pay for a welfare state you don’t get a lot of foreign currency in exchange. Because your money is worthless. And no one outside the country wants it. For what are they going to spend it on? It’s not like Venezuela has a booming export market to shop at. So when you can’t exchange bolivars for US dollars you have to get US dollars some other way. On the black market. So you have a currency that has some purchasing power to pay for those US exports.

So inflation, scarcity and the cost of black market US dollars adds a lot of costs to businesses. Which they have to recover somehow. And the only way they can is through higher prices. Which hurt the poor the most. For they’re not getting big pay raises to keep pace with rising prices. In fact, Venezuelans don’t even want to hold on to their own currency. Because it’s losing purchasing power at such a great rate that the longer they hold on to it the less it will buy. Which is why they want those imports. Because you can’t inflate manufactured goods. So they hold their value. Unlike a savings account full of bolivars.

It’s not the bourgeois capitalist parasites making life miserable for the poor. It’s Venezuela’s socialist policies. Just as similar policies caused people to flee Cuba on rickety boats to get to America. And East Germans risked their lives to climb over the Berlin Wall. If you put two societies close together, one socialist and one capitalist, the flow of people between the two will be from the socialist state to the capitalist state. Which is why socialist states are often police states. So they can prevent their people from escaping their socialist paradise.

Economics 101

To Expand the Money Supply under a Pure Gold Standard requires an Enormous Investment unlike it does for Fiat Money

Do you know why we’ll never have a pure gold standard? Because a pure gold standard doesn’t need a government. Or their economists (from the Keynesian school) advising them how to make the economy better. A pure gold standard works all by itself. And is hard to manipulate. Governments can’t inflate the money supply to spend money they don’t have. So it really takes the fun out of being a spendthrift politician. And because it would work so well it would debunk a century or so of Keynesian economics. And shut down most economics departments at our Universities. Because that’s all they know how to teach. Keynesian economics.

So there is a lot of opposition to returning to a responsible monetary standard like a pure gold standard. Ronald Reagan was the last presidential candidate to include a pure gold standard in the campaign platform. But the idea died quickly after inauguration. Not because he lied. There was just too much political opposition that would never let it happen. For that’s the last thing our spendthrift politicians in Washington want. Something restraining them from spending what they don’t have. As that would only make it more difficult to buy votes. Reward campaign donors. And reward special contributors with federal jobs in an ever expanding federal bureaucracy.

No, what the spendthrift politicians like is fiat money. The kind you make up out of thin air. Easily. And with very little cost. Either by printing paper dollars. Or adding numbers to an electronic ledger. Something you can’t do when you use gold. Because to expand the money supply under a pure gold standard requires an enormous investment to find it. To dig the ore out of the ground. To comminute it (break it into smaller pieces) usually by crushing and grinding. To smelt it. To separate the gold from everything else pulled out of the ground with it. And add it to the money supply. This process takes a while. And costs an enormous amount of money. Unlike fiat money. Where they can simply expand the money supply with a few computer key strokes. Over a cup of coffee.

The Keynesian Interest Rate will always have a Larger Inflation Factor Included than a Gold Standard Rate

Gold mining requires gold mining companies. And these gold mining companies have to raise a lot of capital to finance their extraction of gold. Often with stocks and bonds. So digging gold out of the ground requires investors to take great risks with their investment portfolios. So it takes a lot to get gold out of the ground. Which is why under a gold standard you can never have runaway inflation. Technically you could. But it would require the company to invest an inordinate amount of money into that inflation. And if they flooded the market with all of that gold it would only lower the price of gold. So they would spend more to earn less. Something a private company is not likely to do. Which is why it would be very difficult to impossible to have runaway inflation.

One of the things that makes a healthy economy is low interest rates. If the cost of borrowing money is low more people will borrow money. And if they’re buying things that require loans they’re generating a lot of economic activity. Creating a lot of jobs along the way. This is why Keynesians want to print money. To flood the market with dollars so it doesn’t cost much to borrow them. But there is another factor in interest rates. Inflation. The greater the inflation rate the greater the interest rate. To compensate lenders for the loss in purchasing power over the time of the loan. And increasing the money supply devalues the dollar. Leading to a loss in purchasing power. And those higher interest rates.

As it is much easier to inflate fiat money than it is with gold interest rates are higher with fiat money than they are with gold. Because there is always a risk for governments to print more money for political purposes (i.e., buying votes) there is more cushion built in interest rates. If you remove the irresponsible government aspect from the monetary system interest rates will be lower. Because lenders would ask for less cushion in their interest rates. Because of this stability that gold gives you interest rates are low for extended periods of time. Encouraging lenders to lend. And borrowers to borrow. Leading to economic growth. And jobs. What the Keynesians try to get by printing money. But the Keynesian interest rate will always have a larger inflation factor included. So their interest rates will never be as low as they are under a pure gold standard.

Because Gold is not a Friend of Inflation it is no Friend to Keynesian Economists or Spendthrift Politicians

Under such a gold standard we would not get rid of paper dollars. We’d still have those. Only there would be no fractional reserve banking. Where the banks keep only a small percentage of their deposits in their bank vaults while lending the rest out. Under a gold standard our dollars would be ‘receipts’ for the gold stored in those bank vaults. If the price of gold was $50 an ounce (it’s not) then $1 would equal 1/50 of an ounce of gold. So for every dollar in circulation there would be 1/50 of an ounce of gold in a bank vault somewhere. If you had $500 in your checking account the bank would have 10 ($500 X 1/50) ounces of gold on deposit for you. Which means if everyone came to withdraw their money at the same time everyone would get their money. There would not be any bank runs. And no bank failures like there were during the Great Depression.

But could banks still loan money with a 100% reserve requirement for demand deposits (i.e., checking accounts)? Yes. They would loan money that people deposited for a fixed period of time. Like a 5-year certificate of deposit. Where the depositor can’t withdraw it until that 5-year period is up without a significant penalty for early withdrawal. If a bank makes a 4-year loan with a 5-year deposit the money should be returned to the bank in time for the depositor to withdraw it at the end of 5 years. As most savings are long-term (such as for retirement) this would not hinder lending. There would still be plenty of money to lend. Only there may be tighter lending standards where only people who can actually repay their loans may be able to borrow money. Which would be a good thing. As it would prevent another subprime mortgage crisis from happening.

If the economy grows larger than the money supply there will be fewer dollars chasing all those goods and services. Meaning that the dollar’s purchasing power will increase. And prices will fall. This is something Keynesians all fear (but not consumers who like lower prices). For they say if prices fall there could be another Great Depression. However, the Federal Reserve helped to bring about the Great Recession with their deflationary monetary policies. They contracted the money supply by some 30%. That can’t happen with a pure gold standard. Because the money supply never gets smaller. Because just as you can’t create gold out of thin air you can’t make it disappear. For once they add it to the money supply it is always there. The gold stock never shrinks. It can only grow less than the economy. So you can have a monetary deflation without a depression. Which is a good thing. For your paycheck will go farther. You savings will give you a better retirement. It even makes international trade fair. Because gold is gold. Which makes any currency based on a unit weight of gold difficult to manipulate when it comes to exchange rates. As prices are, essentially, in weights of gold.

So who wouldn’t win under a pure gold standard? Governments with welfare states. Who like to buy votes with their power over the monetary system. Who depend on Keynesian inflationary policies to give them those large sums to spend. And because gold is not a friend of inflation it is no friend to Keynesian economists or spendthrift politicians.

Economics 101

Monetarists believe in Laissez-Faire Capitalism and Fiat Money

Keynesian economics supports hands-on government management of the economy. Using fiscal and monetary policy to move the aggregate demand curve at will to end business cycles. The boom bust cycles between inflation and recession. Leaving only the inflationary boom times. Using tax and spend fiscal policies. Or simply printing money for government expenditures. For in Keynesian economics consumption is key. The more of it the better. And when people stop buying things the government should step in and pick up the consumption slack.

The Austrian school is a more hands-off approach. The markets should be free. Laissez-faire capitalism. And the business cycle should remain. For it is a necessary part of the economy. Part of the automatic pricing mechanism that adjusts supply to meet demand. When people demand more prices go up. Encouraging businesses to expand production to sell at these higher prices (inflationary expansion). Then when supply exceeds demand businesses have excessive inventory that they can’t sell anymore at those higher prices. So they cut their prices to sell off this excessive supply (deflationary recession). Also, that hands-off approach means no playing with monetary policy. Austrians prefer a gold standard to prevent central bank mischief that results in inflation.

The Chicago school of economics takes a little from each of these schools. Like the Austrians they believe that government should take a hands-off approach in the economy. Markets should be free with minimum government intervention. But unlike Austrians, they hate gold. And blame the gold standard for causing the Great Depression. Instead, they believe in the flexibility of fiat money. As do the Keynesians. But with a strict monetary policy to minimize inflation (which is why proponents of this school were also called monetarists). Unlike the Keynesians. For monetarists believe only a government’s monetary policy can cause runaway inflation.

(This is a gross simplification of these three schools. A more detailed and comprehensive study would be a bit overwhelming as well as extremely boring. But you get the gist. At least, for the point of this discussion.)

We used Gold and Silver for Money because it was Durable, Portable, Divisible, Fungible, Scarce, Etc.

At the heart of the difference between these schools is money. So a refresher course on money is in order. Money stores wealth temporarily. When we create something of value (a good or a service) we can use that value to trade for something we want. We used to barter with other creative people who made value of their own. But as the economy got more complex it took more and more time to find people to trade with. You had to find someone who had what you wanted who also wanted what you had. If you baked bread and wanted shoes you had to find a shoemaker who wanted bread. Not impossible. But it took a lot of time to find these people to trade with.

Then someone had a brilliant idea. They figured they could trade their good or service NOT for something THEY wanted but something OTHER people would want. Such as tobacco. Whiskey. Or grain. These things were valuable. Other people would want them. So they could easily trade their good or service for one of these things. And then later trade it for what they wanted. And money was born. For various reasons (durable, portable, divisible, fungible, scarce, etc.) we chose gold and silver as our money of choice. Due to the inconvenience and danger of carrying these precious metals around, though, we stored our precious metals in a vault and used ‘receipts’ of that deposit as currency. And the gold standard was born.

To understand the gold standard think of a balance scale. The kind where you put weights on one side to balance the load on the other. When the scale balances the weight of the load equals the sum of the weights needed to make the scale balance. Now imagine a scale like this where the VALUE of all goods and services (created by talented people) are on one side. And all the precious metal in the gold standard are on the other. These must be in balance. And the sum of our currency must equal the amount of precious metal. (Because they are ‘receipts’ for all that gold and silver we have locked up someplace.) This prevents the government from creating inflation. If you want to issue more money you have to put more precious metal onto the scale. You just can’t print money. For when you do and you don’t increase the amount of precious metal on the scale you depreciate the currency. Because more of it equals the same amount of precious metal. For more currency to equal the same amount of precious metal then each unit of currency has to be worth less. And when each unit is worth less it takes more of them to buy the same things they bought before. Thus raising prices. If a government prints more currency without adding more precious metals on the scale they increase the value of that precious metal when MEASURED in that currency. It becomes worth more. In other words, you can trade that precious metal for more of that depreciated currency than before they depreciated it. You do this too much and eventually people will prefer the precious metal over the currency. They’ll lose faith in the currency. And when that happens the economy collapses. As people move back towards a barter system.

Milton Friedman wanted the Responsibility of the Gold Standard without Gold’s Constraint on increasing the Money Supply

A healthy economy needs a stable currency. One that people don’t lose faith in. Imagine trying to shop without money. Instead, taking things to trade for the groceries you need. Not very efficient. So we need a stable currency. And the gold standard gives us that. However, the thing that makes gold or silver a stable currency, its scarcity, creates a liability. Let’s go back to that balance scale. To the side that contains the value of all goods and services. Let’s say it increases. But the precious metal on the other side doesn’t. Which means the value of that precious metal increases. The currency must equal the value of that precious metal. So the value of the currency increases. And prices fall. It takes less of it to buy the same things it bought before. Not a bad thing for consumers. But it plays havoc with those who borrowed money before this appreciation. Because they now have to repay money that is worth more than when what is was worth when they borrowed it. Which hurt farmers during the 1920s. Who borrowed a lot of money to mechanize their farms. Which helped to greatly increase farm yields. And increased food supplies while demand remained unchanged. Which, of course, lowered farm prices. The supply increased on the scale. But the amount of gold didn’t. Thus increasing the value of the gold. And the currency. Making prices fall. Kicking off the deflationary spiral of the Great Depression. Or so say the monetarists.

Now the monetarists wanted to get rid of the gold supply. The Keynesians did, too. But they wanted to do it so they could print and spend money. Which they did during the Seventies. Creating both a high unemployment rate and a high inflation rate. Something that wasn’t supposed to happen in Keynesian economics. For their solution to fix unemployment was to use inflation to stimulate aggregate demand in the economy. Thus reducing unemployment. But when they did this during the Seventies it didn’t work. The Keynesians were befuddled. But not the monetarists. Who understood that the expansion of the money supply (printing money to spend) was responsible for that inflation. People understood this, too. And had rational expectations of how that Keynesian policy was going to end. Higher prices. So they raised prices before the stimulus could impact unemployment. To stay ahead of the coming inflation. So the Keynesian stimulus did nothing to reduce unemployment. It just caused runaway inflation. And raised consumer prices. Which, in turn, decreased economic activity. And further increased unemployment.

Perhaps the most well known economist in the Chicago school was Milton Friedman. Who wanted the responsibility of the gold standard. But without gold’s constraint on increasing the money supply to meet demand. The key to monetarism. To increase the money supply to match the growth in the economy. To keep that scale balanced. But without gold. Instead, putting the money supply directly on the scale. Printing fiat money as needed. Great power. But with great power comes great responsibility. And if you abuse that power (as in printing money irresponsibly) the consequences of that abuse will be swift. Thanks to the rational expectations of the people. Another tenet of the Chicago school.

INFLATION CAN BE a complicated thing. When there’s inflation, prices rise. But it’s not because evil business owners raise their prices. It’s because the government made money worth less. Let’s illustrate this with a simple example.

Let’s use a lotto. Everyone understands how the lotto works. Those who have winning tickets win the prize. If there is only one winning ticket, the winner claims the whole prize. If there is more than one ticket, the winners split the prize evenly. The more winners there are the smaller each individual’s prize is.

Let’s say the winning prize is 10 gold bars. And let’s say there is only one winning ticket. That one winning ticket is ‘worth’ 10 gold bars. If there are 2 winning tickets then each ticket is ‘worth’ 5 gold bars. If there are 5 winning tickets then each ticket is ‘worth’ 2 gold bars. If there are 10 winning tickets then each ticket is ‘worth’ 1 gold bar. Etc.

If you have one of the winning tickets, you see the value of that ticket decline as the number of winners increase. In the example above, your ticket ‘worth’ in gold bars went from 10 to 5 to 2 to 1. The more winning tickets there are, the less ‘purchasing power’ your winning ticket has. Substitute ‘money’ for ‘winning tickets’ and you have inflation.

NOW LET’S LOOK at prices. The ‘price’ for all 10 gold bars is the total number of winning tickets. In the above example, the ‘price’ in winning tickets increased from 1 to 2 to 5 to 10. The ‘price’ of those 10 gold bars, then, increased as the number of winning tickets was inflated.

This is why business owners raise their prices during periods of inflation. Are these business owners greedy? No more than you. Let me ask you something. If you paid $50,000 for a starter home and put it on the market after it appreciated to $75,000, are you going to sell it for $50,000? Or are you going to be greedy?

All right, let’s say you’re an altruist. You care about people, not profit. You sell your home for $50,000. Now let me ask you something. Do you know what kind of house you can buy for $50,000? Probably not like the kind you just sold. Houses like that now cost around $75,000.

Inflation makes things more costly. And if costs go up, prices go up. They have to. If a business doesn’t cover its costs it will go bankrupt. As would you.

SO IF INFLATION is bad, why do ‘they’ increase the money supply? Here’s the short, short answer. Because ‘they’ like to spend more money than ‘they’ have. I say ‘they’ because it’s complicated who ‘they’ are. The Federal Reserve is responsible for monetary policy. The federal government spends the money. But don’t sweat the details. Suffice it to say that ‘they’ are responsible for inflation. And ‘they’ aren’t business owners.

High taxes have consequences. Usually at the polls. So government looks for other ways to raise money. They can sell debt. Or simply print money. Neither says ‘I’ve increased your taxes’. But they both have the same affect. The inflation they cause increases your cost of living just as a tax increase would have. But it’s hard to blame your misery on the government when they weren’t taking (taxing) but giving (pork barrel spending). Quite the devious bastards, aren’t they?

Not only does the cost of living go up, but the value of your savings decline. If you saved $10,000 in the bank, inflation will make the purchasing power of that $10,000 worth less. $10,000 today won’t buy as much as $10,000 did a decade ago.

This is how inflation destroys wealth. The flip side is that it also reduces government debt. At your expense. If you own government bonds, inflation makes those bonds worth less. You lose wealth. Because they’re worth less, it is now cheaper for the government to buy them back from you. The debt sold a decade ago is ‘cheaper’ to pay off today.

SHORT TERM DEFICIT spending can be beneficial. If it’s used to cut taxes to stimulate the economy (like JFK and Reagan did). An increase in economic activity can generate more tax dollars even at a lower tax rate. This can close the gap in the budget between spending and revenue. However, if government continues deficit spending only to buy political favor (like FDR and LBJ), there will probably not be a corresponding increase in economic activity. The gap between spending and revenue will probably not decrease. In fact, it will probably increase. And unchecked deficit spending will most probably result in runaway inflation. Sooner or later. And you know what the consequences of that can be. If you don’t, you can ask Jimmy Carter.